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Wednesday, September 24, 2008

Whether or not tomorrow’s accounts of today’s turmoil prove David Owen of Dresdner Kleinwort right; whether or not this is the beginning of the end of the dollar’s pre-eminence in the world’s central banks and foreign exchanges, the economic landscape has undoubtedly changed forever.

The US taxpayer bail-out of America’s banking sector is an event whose significance will reverberate for many years. What it means for free markets, for the way Western economies are run, for the prosperity of the world economy, must remain to be seen.

But as investors scrambled to make sense of last week’s events, already one conclusion was all but irrefutable – the US dollar will have to take another major fall.

The dollar rally that began in July and pushed the pound’s value against the greenback significantly lower has come to an abrupt end as markets face up to the fact that the currency will have to absorb the effects of a sudden shocking increase in America’s budget deficit.

When Treasury Secretary Hank Paulson announced that the world’s biggest economy was about to embark on the world’s biggest bail-out for its financial sector, the first concern economists had was about the long-term prospects for the nation’s finances and its currency.

Might the dollar now be vulnerable to a run? In the longer term, might this signal the beginning of the end for the dollar’s status as the world’s reserve currency?

The US Treasury was already planning to borrow $438bn (£237bn) next year to shore up its budget deficit. That could now rise to $1 trillion or more after the cost of the $700bn mortgage rescue fund is taken into account. Budget deficits of that kind are usually enough to scare many foreign investors away, and indeed the dollar slumped 1.1 cents to $1.8441 against the pound yesterday, and in late trading was down almost two cents against the euro at $1.46880.

Ironically, despite the pound’s comparative strength against the dollar – having risen from just above $1.75 in the past few weeks – it remains extremely weak against other world currencies, due to investors’ fears about the UK’s own home-grown problems.

“The magic trillion-dollar deficit is within sight,” says Simon Derrick, of Bank of New York Mellon, “The combination of the fiscal position and loose monetary policy is likely to be significantly dollar-negative. With an expanding supply of US paper they might want to hold something else as their safe haven, which might mean other currencies and might just as easily mean commodities such as gold.”

When a government opens the spending taps and borrows more, investors invariably take flight, fearing that assets denominated in those currencies will lose their value as inflation rises and the currency weakens.

However, with the Treasury still reluctant to spell out precisely how the rescue package, modelled on the late 1980s’ Resolution Trust Corporation, will work, analysts are still unclear about how far the dollar has to fall.

It is likewise still unknown precisely what effect the quasi-nationalisation of Fannie Mae and Freddie Mac will have for the nation’s finances, though the implications will again almost certainly be negative.

According to Mr Derrick, “the sums have changed so quickly on the fiscal side within the space of two weeks, and clearly the outlook for the US economy relative to where people were forecasting before Freddie and Fannie. Investors will also have a radically different outlook for the future.”

The biggest question, however, is whether the reserve managers in central banks in China and elsewhere will treat this as a justification for selling off some of their massive mountain of dollar-denominated investments. If this were to happen, it could cause a catastrophic drop in the US currency, potentially compromising its status as the world’s reserve currency.

However, with the euro area facing its own economic and financial crises, it looks unlikely to be able to step into the breach. This helps explain the leap yesterday in gold and oil prices as investors seek to buy tangible commodities in place of currencies that may easily be devalued in the coming years.

What was perhaps even more worrying for investors was an item in the small print of Hank Paulson’s rescue plan. It said that, separate to the $700bn markets rescue package, the US Treasury would plunder the Exchange Stabilisation Fund – the US currency reserves, established in the 1930s – in order to pay for an insurance scheme for the money markets.

“The Treasury has committed the nation’s FX reserves to supporting the money market industry,” said Chris Turner, head of foreign exchange strategy at ING. “That suggests to us that the dollar has fallen down the list of the administration’s priorities – a worrying development for foreign investors in the US.”

The fund’s cash is being funnelled into a new scheme designed to protect money market mutual funds, which mirrors the Federal Deposit Insurance scheme for consumers’ bank savings. “What worries us is that the US Treasury has committed the nation’s FX reserves at a time when the dollar is exceptionally vulnerable,” said Mr Turner.

4 comments:

Anonymous
said...

Treasury Secretary Henry Paulson's $700 billion plan to buy devalued assets from financial companies is ``a joke'' because it doesn't go far enough to calm markets, said Kenichi Ohmae, president of Business Breakthrough Inc. Ohmae, nicknamed ``Mr. Strategy'' during his 23 years as a McKinsey & Co. partner, called for a $5 trillion ``international facility'' to be made available to financial institutions.

The US is collapsing.. I immigrated to the US ten years ago... but what I have seen there is causing me to now leave... an obese, ignorant, greedy, corrupt and truly dumb and arrogant people.. who know nothing about the rest of the world... the majority of whom couldn't find Canada on a map let alone Afghanistan... a country which is going to show the Americans how to loose yet another war....they are getting what they deserve.. God how I hope gun totin' Palin wins.. as you just know McCaine ain't gonna last eight years.. then the world will see how absolutely stupid Americans are.. with a president who believes the world was created four thousand years ago... God help them.. God help the rest of the world..and God screw the U.S.A !!

Many intelligent people knew of the criminality going on, on Wall Street for years. Many warned Congress and the Senate. These so called "representatives of the people" did nothing, absolutely nothing, because they are and were so bought off by the big corporations. But it goes further than that. Wall Street has been dealing in a kind of Voodo, where money is generated from debt, in a recurring cycle that creates nothing but money. Not for the purpose of expanding any business, of building any building or bridge, but of enriching those working on Wall Street. It is a totall disconnect from society and its needs. It is criminality of the first order.

Several have been predicting this over many years due to the abuses by financiers, regulators and just basic foolishness by government officials.

These elitists must be held accountable and pay the price that any failed leader MUST pay in order to set the record straight. If they once again are protected and escape the public scrutiny and justice, then its guaranteed that the abuses will continue in some form and our Democratic system will be further corrupted.